Public Investment and Corruption in an Endogenous Growth Model

Abstract

High capital spending is favored by economists and politicians for its beneficial effects on economic growth. However, there is empirical research associating high levels of public investment with low economic growth due to corruption. I provide an endogenous growth model with Ramsey taxation that is consistent with this empirical finding. In the model, government maximizes the weighted average of consumers' utility and its own utility coming from expropriation of tax revenues. The weight determines the benevolence of the government. I show that a self-interested government sets a higher public-to-private-capital ratio than a benevolent one, reducing the productivity of public capital, in order to use more of the tax revenues for its own consumption. While a large public-to-private capital ratio increases the productivity of private investment, high taxes that come along with high public capital spending reduce the after-tax returns to private investment, causing the growth rate to be low.

Haque, M. E., and R. Kneller (2008): “Public Investment and Growth: The Role of Corruption,” Centre for Growth and Business Cycle Research Discussion Paper Series 98, Economics, The University of Manchester.

Heston, A., R. Summers, and B. Aten (2006): Penn World Table Version 6.2 Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania.

Keefer, P., and S. Knack (2007): “Boondoggles, Rent-Seeking, and Political Checks and Balances: Public Investment under Unaccountable Governments,” The Review of
Economics and Statistics, 89(3), 566-572.

Mauro, P. (1997): “The Effects of Corruption on Growth, Investment, and Government Expenditure,” in Corruption and the Global Economy, ed. by K. A. Elliott. Institute of International Economics, Washington D.C.